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Cheap Money: Why the Debt-Limit Fight Matters

Mark Trahant

1/17/13

It’s easy to be gloomy about the prospects of the United States government. The country, after all, owes a boatload of money and the political debate about how to solve that problem is both rancorous and ineffective.

And programs for American Indians and Alaska Natives are a tiny fraction of that spending – yet we will soon see the impact from substantial, across-the-board budget cuts, hitting communities were jobs are scarce.

So how about a little good news? The United States can borrow money for almost nothing. A two-year Treasury bond pays one-quarter of one percent. A five-year note is a bit more expensive, three-quarters of one percent. And, a thirty-year note is 3.01 percent. (How does this compare to other nations? Investors in Swiss bonds actually get a return of less than what they pay for bonds. On the other hand, an investment in some Greek bonds earned 80 percent last year because of the risk.)

That’s what’s crazy about the current debt limit fight. Investors from all over the world are willing to pay the United States practically nothing for a promise that we will pay them later.

The top priority in Congress ought to be to not mess this up.

Yet over the next four-to-six weeks that is exactly what might happen. Congressional Republicans are willing to wreck one asset that’s golden – the perception that our bonds are safe – in order to force austerity through more budget cuts. Treasury Secretary Tim Geithner said yesterday we could hit the limit on federal borrowing authority as soon as mid-February.

If congressional Republicans refuse to pay America’s bills on time, Social Security checks and veterans’ benefits will be delayed. We might not be able to pay our troops, or honor our contracts with small business owners. Food inspectors, air traffic controllers, specialists who track down loose nuclear material wouldn’t get their paychecks. Investors around the world will ask if the United States of America is, in fact, a safe bet. Markets could go haywire. Interest rates would spike for anybody who borrows money – every homeowner with a mortgage, every student with a college loan, every small business owner who wants to grow and hire. It would be a self-inflicted wound on the economy. It would slow down our growth, might tip us into recession, and ironically, would probably increase our deficit.

So to even entertain the idea of this happening – of the United States of America not paying its bills – is irresponsible. It’s absurd. As the Speaker said two years ago, it would be – and I'm quoting Speaker Boehner now – “a financial disaster, not only for us, but for the worldwide economy.”

So we've got to pay our bills. And Republicans in Congress have two choices here: They can act responsibly, and pay America’s bills; or they can act irresponsibly, and put America through another economic crisis. But they will not collect a ransom in exchange for not crashing the American economy. The financial wellbeing of the American people is not leverage to be used. The full faith and credit of the United States of America is not a bargaining chip.

One of the problems in looking at debt and deficits is that the numbers are so huge. The sheer size of the debt makes it look like the worst moment in American history. But if you view the debt from a perspective of time, or through the lens of a percentage of the economy, then the problem is much more manageable.

For example as Dean Baker, from the Center for Economic and Policy Research, has pointed out: “Suppose we issue $4 trillion in 30-year bonds in 2012 at 2.75 percent interest (roughly the going yield). Suppose the economy recovers, as CBO predicts, and the interest rate is up around 6.0 percent in 4-5 years. The federal government would be able to buy back the $4 trillion in bonds it had issued for roughly $2 trillion, immediately eliminating $2 trillion of its debt. This will make those who fixate on the debt hysterically happy, but will not affect the government's finances in the least. It will still face the same interest obligation.”

Conversely: If we, through a self-inflicted wound, let interest rates go up. Then we take away one of our best policy tools that could be used to reduce the debt totals.

In the 1940s that is exactly what happened. According to the Government Accountability Office net interest payments spiked driving up the federal deficit. “Rising debt, in turn, raised interest costs in the budget, and the federal government increased debt held by the public to finance these interest payments. This has been called the ‘vicious cycle,’” GAO reported.

The cycle would be worse this time around (and it’s why we have to fix our long-term budget). Interest payments would crowd out every program that people care about.

But doing that right now, over a debt limit fight, makes no sense.

Mark Trahant is a writer, speaker and Twitter poet. He lives in Fort Hall, Idaho, and is a member of The Shoshone-Bannock Tribes. Join the discussion about austerity. A new Facebook page has been set up at: https://www.facebook.com/IndianCountryAusterity

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Dean Baker's thinking, as cited in this article, is problematic. His math is indeed correct regarding the cost of interest on an additional $4 trillion borrowed today if tomorrow's interest rate rises to 6%. However, it ignores the problem of paying for the debt that the country has already stacked up.
As it stands, interest on the current national debt ($16.4 trillion) eats up 17 cents of every dollar collected in taxes. So let's play along with the scenario that Baker describes. We add an additional $4 trillion in debt, and then refinance the additional $4 trillion for $2 trillion at 6%. Now the debt is $18.4 trillion at 6% (because the US Treasury is constantly refinancing the entire US Debt current interest rates) and service of that debt will cost 42 cents of every dollar collected in taxes. When this happens the government will be in a financing crisis and will not at all face the same interest obligation - it will be far worse.
The short answer is that there is no such thing as free money. Perhaps the debt limit fight isn't the most timely opportunity to address this, but as you point out at the end of the article, if we don't deal with the debt crisis then interest payments WILL crowd out every program that people care about.
Sandy McMahon
Adjunct Instructor of Macroeconomics
Southwestern Indian Polytechnic Institute